Homeowner loses bid to deduct mortgage interest on $1.1 million of debt

The Tax Court has rejected a taxpayer's attempt to deduct interest paid on her $1.1 million of indebtedness on her home. The plain language of the Tax Code limited her deduction to $550,000 because she elected to file her return as married filing separately. It did not matter that her husband did not take any mortgage interest deduction, that she paid all the interest, or that she owned the house jointly with her father-in-law who lived elsewhere.

Home purchase

The taxpayer purchased a home in 2007. Her co-purchaser was not her husband but her father-in-law, although only the taxpayer and her husband, and not her father-in-law made it their principal residence. They each co-signed the $1 million mortgage, which was secured by property. On her 2007 federal income tax return, the taxpayer deducted $52,000 in home mortgage interest. The taxpayer filed her 2007 return as married filing separately.

The IRS examined her return and limited her deduction to $27,000. According to the IRS, the taxpayer could not deduct interest paid on the entire $1 million of indebtedness. Rather, her deduction was limited to $500,000 of her home acquisition indebtedness and $50,000 of her home equity indebtedness. The Tax Court agreed.

Plain language controls

Generally, taxpayers may deduct qualified residence interest (interest on acquisition indebtedness and home equity indebtedness) Qualified residence interest is interest paid or accrued during a tax year on acquisition indebtedness or home equity indebtedness with respect to the taxpayer's qualified residence.

According to the court, the language in the Tax Code is very clear. The aggregate amount treated as acquisition indebtedness for any period cannot exceed $1 million ($500,000 in the case of a married individual filing a separate return). The aggregate amount treated as home equity indebtedness for any period cannot exceed $100,000 ($50,000 in the case of a separate return by a married individual). If Congress has intended otherwise, it would have written the statute differently. The plain language of these provisions limited the taxpayer's deduction for the interest paid on $550,000 of the mortgage indebtedness. The court also upheld a stiff 20 percent accuracy-related penalty, finding that the taxpayer had no substantial authority or reasonable basis on which to base her treatment of the mortgage interest paid.